Currently, brokerage firms in the financial securities trading business, offer direct securities transactional services through ECNs (electronic communication networks), ATS's (automated trading systems), exchanges, or other brokerage systems, to securities wholesalers often referred to as “market makers”. To initiate a transaction, the brokerage firms generally require orders to buy or sell securities to be entered onto their automated system. The orders are then acted on by the brokerage firms either by (1) executing immediately if they are marketable or (2) holding with passive limits until others enter market orders, which allow the orders being held to be executed. Functionally, holding orders with limits imposed gives a brokerage firm an option on whether to take an order or not. This option has value because it effectively gives the brokerage firm a competitive advantage over the market maker.
This is illustrated as follows. Passive order sending firms (or market makers/wholesalers) are forced to put orders or quotes out and the market makers participate against whatever comes. From the market maker's perspective, if the order is a buy order for 1,000 shares, it is very good to have 200 share sell orders that come to hit the quote. But the 200,000 share sell orders are not very good in that they take out the 1,000 shares as well as the next five levels, i.e., the price is distorted in the marketplace. This is a problem for any firm placing limits or quotes into an automated marketplace. This possible scenario forces any firm using limits in an exchange/ECN system to place smaller orders than they might be interesting in taking naturally.
Functionally. placing limit orders into such systems gives the opposing side an option on whether to take ones order or no; that option has value. The present invention flips the situation and permits an option to participate against an incoming market order. The value of the option can belong to the market makers, which is extremely significant and not well understood in today's marketplace.
A transactional practice is needed that would give the market maker the opportunity to share with the brokerage firm the value of the option created by holding with passive limits. That is, the market maker would prefer to see brokerage firms' orders prior to their introduction to the market.
By way of the above example, given the choice prior to the introduction of the 200,000 share sell order, the market maker could decide not to participate, but would participate when given the opportunity to interact with the 200 share sell order. The main issue becomes the brokerage firm does not wish to disclose the fact that a 200,000 share sell order is about to hit the market due to fears of front running, which is defined as an illegal activity in which a trader takes a position in an equity in advance of an action which he/she knows his/her brokerage will take that will move the equity's price in a predictable fashion (also called forward trading). Until now, this limitation has kept such a market or system from being created.
Brokerage firms are concerned that prior information about their security trading intentions given to market makers would be leaked to the general market, which would likely distort the price of the security to be traded. If brokerage firms could anonymously (i.e., without revealing their identity) announce their trading intentions to market makers, they would be willing to do so. Thus, a significant barrier to creating the needed transactional practice has been the lack of anonymity.